Higher correlation, less stocks. What? stocks, minimum, possible, investor, only

meghanjackson

From p.393 of Vol6.

If the correlation among stocks were 0.1, the investor would need 90 stocks in the portfolio to obtain 110% of the minimum possible portfolio variance. If correlation amonng stocks were 0.5, the investor would only need 10 stocks.

I don't get the logic of needing less stocks if they're highly correlated. Shouldn't we be taking more to reduce the effect of high correlation?

SeanWest

Because with a lower avg correlation the are greater possible benefits of diversification. With avg corr of 0.1 the maximum benefits of diversification is equal to 10% of the avg variance. so 110% would be 11% of the average variance. with p = 0.5 the maximum benefits of diversification are 50% of the avg variance... therefore 110% would be 55% of the average variance.


because the lower correlation stocks have such greater potential diversification benefits the portfolio requires a larger # of these stocks in order to achieve these benefits.